Secure Retirement: Connecting Financial Theory and Human Behavior

274 Pages Posted: 7 Nov 2019

Date Written: September 18, 2019


Investors fear return uncertainty and drawdowns associated with owning relatively risky asset classes, such as equity. The fact that greater risk is associated with greater expected return does not preclude the possibility that realized returns may be far less than a low-risk asset could provide, even with horizons as long as 5 to 10 years. Fear prompts the average investor to sometimes act against his own best interest. Therefore, the average investor’s portfolio often underperforms a static benchmark, even before fees. The average investor tends to increase allocation to riskier assets after the market has already significantly risen and decrease allocation after a significant decline.

Given that financial planning in the context of retirement is a multidecade endeavor that can last 50 years or more, investors face an additional challenge. Financial planners cannot be concerned solely with “managing” the behavior of investors facing short-term return uncertainty, which remains an important challenge, but must also be concerned with how to address longer-term uncertainties. For example, there is significant uncertainty about the assumption for long-term expected returns, real as well as nominal. Some lucky investors may accumulate much of their wealth before retirement during an exceptionally strong bull market (e.g., 1982 to 2000), whereas less fortunate investors may have been planning to retire in 2008 or early 2009, just after the most dramatic global liquidity crisis since the Great Depression and a significant decline in interest rates. Moreover, average expected returns represent only part of the story. Some investors may have recorded above-average returns at a time when their accumulated wealth was already significant, whereas others may have recorded above-average returns when their accumulated wealth was low. The implication of the interactions among savings patterns (in accumulation), withdrawal patterns (in decumulation), and timing of above- and below-average portfolio returns is important to understand, particularly with respect to how the interactions should affect the allocation policy.

Furthermore, investors face significant risks in the transition period — say, the last 5 to 10 years — from accumulation to decumulation. Considering the uncertainty in long-term expected returns, patterns of returns, and patterns of savings, it is unlikely that a financial plan established when an individual is 30 years old can remain static thereafter. The plan must be revaluated periodically, which requires an effective feedback mechanism or tool. The investor has many more options available before retirement, however, although some may not necessarily be pleasant. In the event of lower than expected accumulated wealth, the investor could decide to save more, postpone retirement, and/or adjust retirement plans. These options may be unavailable or may be harder to implement once the decision to retire has been made. The investor must implement a transition strategy that reduces the likelihood and/or significance of the unplanned adjustments that may be necessary as the targeted or desired retirement date draws near.

In addition, longevity remains uncertain, and retirement plans often are based on expected longevity. Even though the median life expectancy for a 65-year-old individual in the United States is 83.3 years for men and 85.9 years for women, a significant percentage of people will live past age 90. Furthermore, as someone ages, the older she is expected to live. A dynamic issue, life expectancy becomes even more complicated in the context of a couple — one or both individuals could live a very long time. This possibility should also influence the allocation policy over time and the potential need for longevity insurance.

Finally, governments in many countries have implemented policies and programs to support the retirement effort. The most important program in the United States is Social Security, but its purpose is to provide only a minimum level of inflation-adjusted income, not to sustain the standard of living that an individual had before retirement. Other programs seek to encourage savings and facilitate wealth accumulation, such as 401(k)s, traditional and Roth IRAs (Registered Retirement Savings Plans and Tax-Free Savings Accounts in Canada), and health savings accounts (HSAs). Most investors, however, underestimate the savings effort required to maintain the standard of living to which they are accustomed, cannot implement a comprehensive and coherent adaptive retirement plan, cannot optimize across all relevant parameters, and lack access to the feedback mechanism needed to make the appropriate adjustments over time.

Suggested Citation

Lussier, Jacques, Secure Retirement: Connecting Financial Theory and Human Behavior (September 18, 2019). CFA Institute Research Foundation Publications, September 2019, ISBN 978-1-944960-81-0, Available at SSRN: or

Jacques Lussier (Contact Author)

CFA Institute ( email )

915 East High Street
Charlottesville, VA 22902
United States

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